Service Charge vs. Tip: What Restaurants Need to Know

In the restaurant industry, it’s common knowledge that diners — particularly those in the United States — are expected to leave a tip for their server at the end of a meal. This partially stems from the U.S. Department of Labor setting minimum wages for tipped employees much lower than the federal minimum wage in other industries to account for tips. 

But more and more diners are noticing other charges, often referred to as service charges, on their restaurant receipts. These charges have guests asking, “is a service charge the same as a tip?” 

So, let’s take a closer look at service charges and tips, and how each of them plays a role in the restaurant industry today.

In this article, you will learn:

• What a service charge is

• What a tip is

• Why the difference between service charges and tips matters for IRS (Internal Revenue Service) reporting

• How to implement a service charge in your restaurant

What is a service charge?

A service charge, which may also be referred to as a service fee or an automatic gratuity, is an additional fee that is collected in exchange for a product or service on top of the cost of the goods. Typically, this charge is incurred at the time of the service transaction and is included in the total bill.

Here are some common situations in which you may have experienced service charges:

• In the banking industry: When you use an ATM at a bank you don’t have an account with, you may be charged a few dollars in the form of a service charge

• In the travel industry: When you’re booking a flight and your luggage is oversized

• In the hospitality industry: When you book a stay using the online rental platform Airbnb, you are charged a fee as a percentage of your rental total

• In the utility sector: When you call your internet provider to install new fiber optic cable lines for your home WiFi, you are likely to be charged a service fee

• In the entertainment industry: When you purchase concert tickets online using a service like Ticketmaster or StubHub, your total is likely to include not just the ticket price but also a service charge

What is a service charge at a restaurant?

Service charges are becoming increasingly common in the food service industry as well. Restaurant owners may choose to add a service charge to a bill for various reasons, including but not limited to:

• An automatic gratuity for large parties, for example, if your party has more than eight guests. These are typically around 18% of the total bill.

• A bottle service charge in a bar or nightclub. This charge varies greatly based on the location and exclusivity of the club.

• A room service charge for a hotel restaurant, typically 15% of the total bill but may also include flat rate fees.

• A mandated delivery fee for online delivery orders, such as pizza delivery. This is typically between $2-$5 and is not the same as a tip as it does not typically go to the driver.

• A banquet event fee or catering service charge for large-scale catered events. This ranges from 18-25% depending on the size, nature, and location of the event.

An important thing to note about a service charge is that it goes directly to the restaurant or business and they are able to allocate that money as they see fit (with some exceptions that we’ll go over later). Unlike a tip, service charges do not always go directly to the employee who took care of you. Rather, they are considered non-tip wages and are required as part of the bill payment, unlike tips which are optional.

Service charge vs. tip

Now that we’ve covered service charges, let’s get into the details of how they’re different from tips.

A tip, also referred to as gratuity, is a discretionary, additional payment on top of a check total given as a token of gratitude for good service and great hospitality. Tipping is common in the service industry as a way to thank the service worker — whether it’s a nail tech at a salon or a bartender, server, or busser at a restaurant — for their time and service. So, the first main difference between a service charge and a tip is that one is mandatory while the other is optional.

Another difference is how they’re allocated. While service charge allocation is largely up to the restaurant owner’s discretion, tips typically go directly to the server or into a tip pool. A tip pool is when a portion or all of the tip money from the night is collected and redistributed evenly or by a set percentage — instead of each individual server keeping the tips they earned individually. Ownership, managers, and supervisors are never allowed to be included in a tip pool. Only in certain jurisdictions, when the employer is paying full minimum wage (i.e. not the tipped minimum wage), may back-of-house employees may be included. Otherwise, those folks are off-limits as well. 

So, you may be wondering, do you tip on top of a service charge? In most cases, the answer is yes. Since a service charge is not guaranteed to go to the server themselves, leaving a tip is a great way to thank your waiter for their hospitality.

Should you implement a service charge?

Service charges are becoming more and more popular in restaurants. As the industry continues trending in the direction of equitable living wages for all employees, restaurateurs are leaning on service charges to support their staff while increasing profitability.

Rather than raise menu prices, many restaurant owners are fighting inflation and rising costs by implementing service charges to account for their increased cost of goods. Others are using service charges to provide higher employee wages and benefits packages.

But service charges go beyond just good business — they’re actually categorized differently by the IRS than tips. As a restaurant owner, knowing the difference between a service charge and a tip is vital when it comes to IRS reporting.

Four factors are used to determine whether a payment qualifies as a tip. Normally, all four must apply. To be a tip:

1. The payment must be made free from compulsion;

2. The customer must have the unrestricted right to determine the amount;

3. The payment should not be the subject of negotiations or dictated by employer policy; and

4. Generally, the customer has the right to determine who receives the payment.

If any one of these doesn’t apply, the payment is likely a service charge.

How to implement a service charge in your restaurant

Once you’ve decided that implementing a service charge is right for your restaurant, it’s time to determine how to do so.

For Good Good Culture Club in San Francisco, CA, that takes the form of doing away with optional tips entirely. Instead, the innovative full-service restaurant has implemented an equitable compensation fee. This service charge takes the form of a 20% fee on all checks, which is distributed fairly to hourly staff. As a result, guests no longer see a tip line on receipts.

If this option feels too out-of-the-box for your restaurant’s service model, no sweat. Most restaurants choose to implement a service charge for unique use cases — such as for large parties or bottle service, as outlined above — and still allow front-of-house staff to accept optional tips as well.

Here are some tips to successfully implement a service charge or automatic gratuity in your restaurant:

• Decide on your service charge. Restaurant service charges typically range from 3 to 20% of a customer’s bill. However, this total, as well as what the service charges are used for, varies greatly based on the location of the restaurant. When deciding on a service charge rate for your restaurant, keep in mind how the newly added service charge may change the tipping behavior of your guests.

• Set clear expectations with your guests. Since service charges are a requirement set by the restaurant and are not optional as with standard tipping, it can be helpful to communicate the service charge to the guest at the beginning of service.  Some restaurants also choose to include language on their website explaining the service charge and how they allocate the funds to provide better transparency into the increased cost for the guest.

• Determine how you’ll allocate the funds. Since service charges are different than tips, they are not required to go to the waitstaff who served that table. However, some states do dictate how a service charge can be used.  For example, The Massachusetts Tips Act states that service charges must go to the front-of-house staff and may not be given to back-of-house employees such as cooks or dishwashers. However, Massachusetts restaurants can still implement house or administrative fees that can be allocated outside of the FOH team, provided the employer “provides a designation or written description of that house or administrative fee, which informs the patron that the fee does not represent a tip or service charge for wait staff employees, service employees, or service bartenders.”  Many restaurants use service charges to provide employee health care or simply boost the restaurant’s bottom line. In short, make sure that you’re aware of the laws and regulations in your state and local municipality when determining how to allocate service charges.

Service charges in your restaurant

As with any big decision related to your restaurant, you shouldn’t make it alone.

Ask your staff and loyal guests how they feel about service charges. By taking the time to ask your staff, you’re communicating to them that you value their input and care about their well-being as employees. And while some guests may shy away from spending more, they’re more likely to understand the need for service charges if you’re open and honest about why they’re being implemented and how the money is being allocated.

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